Rating agencies like Standard & Poor's, Moody's and Fitch analyze the risk associated with the debt and give debt a "grade" accordingly and that reflects the borrower's ability to pay the underlying loans.
Losing your rating or being downgraded can affect your country's ability to borrow money from the markets.
The downgrade doesn't actually mean the country will default but it is just a negative change in the rating of the country. This situation occurs when the rating agency feel that the future prospects of the country have weakened and they are uncertain of the government's ability to meet its debt obligations.
Implications of the U.S. Downgrade
- Risk premium on U.S. Treasuries would increase.
- Investors will demand higher interest rates from the federal government which would in turn increase the cost of borrowing for the U.S. Government and make borrowing costs higher for consumers and businesses across the country.
- Stock markets might tumble, increasing borrowing cost for the company would affect their profitability which in turn could have an impact on their share price.
- U.S. Treasury bonds, which are considered to be as the safest security in the world, can face sell-off due to emerging risk.
- As investors will demand a greater return for their investment, so the interest rate and yield of treasuries can go up and the prices may decline.
- Investors may look for alternate investment options like precious metals and commodities, more demand may push prices of precious metals and commodities little further.
- This would create additional pressure on Congress for fiscal discipline and debt reduction going forward.
- There will also be a possible negative impact on consumer confidence further increasing unemployment levels, corporate earnings, consumer spending, investments, etc.
But many analysts say the impact could be modest because the other ratings agencies, Moody"s and Fitch, have decided not to downgrade the government at this time.
The bottom line is that a U.S. AA+ is more delicate than AAA and there is lot of danger associated with a downgrade. In short run, this downgrade would do weird things on the street and could tremble the financial markets around the world.